Abstract

We investigate the role of information-based trading in affecting asset returns. We show in a rational expectation example how private information affects equilibrium asset returns. Using a market microstructure model, we derive a measure of the probability of information-based trading, and we estimate this measure using data for individual NYSE-listed stocks for 1983 to 1998. We then incorporate our estimates into a Fama and French ~1992! asset-pricing framework. Our main result is that information does affect asset prices. A difference of 10 percentage points in the probability of information-based trading between two stocks leads to a difference in their expected returns of 2.5 percent per year. ASSET PRICING IS FUNDAMENTAL to our understanding of the wealth dynamics of an economy. This central importance has resulted in an extensive literature on asset pricing, much of it focusing on the economic factors that influence asset prices. Despite the fact that virtually all assets trade in markets, one set of factors not typically considered in asset-pricing models are the features

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